Rewarding good work

You're in the closing stages of a job offer and all that's left is to negotiate your salary. So what would you prefer - a good (but not flash) fixed income with no "at risk" component or a lower base salary with an opportunity to earn more based on performance?

Beware how you decide to cut the cake, warns Sherry Maier, reward practice manager with Sheffield.

Maier says managers uncomfortable with having too much pay wired to performance risk signalling fear of failure to their bosses.

On the flipside, firms that don't link a manager's pay to an "at-risk" (or performance-based) component are subconsciously hinting it's okay to under-perform.

Any company serious about results, should hire and retain risk-takers.

"Instead of raising doubts about your ability to perform under pressure, performance-pay programmes should act as motivator and retention tools," says Maier.

"Managers without performance-pay programmes risk leaving money on the table - that's assuming they can deliver on key performance criteria."

They are not a magic bullet but, when designed properly, performance-pay programmes are an effective tool for creating upside by focusing managers on areas that create the most value.

Maier's initial glance at Sheffield's soon-to-be-released annual CEO survey suggests the incidences of managers on performance-pay programmes has slumped.

She attributes this to naivety about how these programmes should be set up and disillusionment when they fail to deliver.

Similar disillusionment over long-term performance incentives such as share options - that hitch fortunes to a share price - means most performance-pay programmes come as annual cash bonuses.

"Unfortunately, too many firms write off their performance-pay programmes before they have had sufficient time to work," she says.

Maier believes the trick is to keep these programmes simple by aligning performance pay with only a few goals, for example profit, growth, and customer satisfaction.

"Some HR people and CEOs relegate performance-pay programmes to the too-hard basket," says Maier. "Meanwhile, some firms forget to keep checking whether these programmes continue making sense."

She suspects the frequency with which badly constructed performance-pay programmes fail locally explains why New Zealand's executive pay stakes resemble most closely China's model when compared with other global economies.

In fact, not only are fewer Kiwis managers exposed to a performance-pay component, those who are have far less pay "at risk" than their Australian counterparts.

For example, while senior managers in Australia have between 30 and 40 per cent of their total remuneration linked to performance, Maier says the experience of Kiwi managers is around half that figure.

Nevertheless, Brent Miller, consultant with remuneration specialist Watson Wyatt, argues there is sufficient evidence to prove that managers on a performance-pay programme earn more than those on fixed-based salary.

Assuming they are designed properly, he claims performance-based pay programmes will deliver win-win outcomes for participating managers and companies .

Simplicity aside, Miller advises the key to designing annual bonus programmes for managers is ensuring the individual's goals align with the organisation's.

He says performance-pay programmes complement managers who are confident in their ability to exceed company expectations, and cites the experiences of an ailing manufacturer.

Instead of accepting a base salary of $250,000 with no "at risk" component, the CEO - appointed to resurrect the company's fortunes - offered to take a base salary of $140,000 and the rest "at risk" based on a generous upside.

After a year turning around the company's fortunes the CEO walked away with total remuneration close to double the amount the company offered him initially.

Sadly though, he says performance-pay programmes invariably fail when performance measurement systems aren't in place.

Though it is important not to encourage "risky behaviour" by making these programmes too generous, Miller argues there is as much risk in making performance criteria too ambitious.

The two main dangers are creating unrealistic output expectations and mismatching the offer to the job.

"The last thing a company wants is an executive working so hard to deliver on financial opportunities they destroy the culture of the organisation," says Miller.

While financial results are the ultimate measure of a CEO's performance, he says managers lower down the company tree are often measured on much broader key performance indicators (KPIs).

In addition to the "hard numbers", he recommends an effective incentive plan comprising measures reflecting the business unit they manage, team and personal performance, plus the desired behaviours the company wants to encourage.

Some of the specific non-financial KPIs Miller recommends include:

* Staff and key client retention

* Developing supplier relationships

* Systems implementation

* Feedback to employee satisfaction surveys

How to make performance pay schemes work

* Ensure performance pay programmes deliver win-win outcomes
* Give them sufficient time to work
* Keep the goals simple
* Ensure executive/company goals align
* Develop good performance measurements
* Don't mismatch the offer to the job
* Don't encourage risky behaviour
* Create realistic output expectations
* Balance financial measures with other KPIs
* Reward against "key impact" areas
* Understand the upside for achieving "at-risk" pay.
* Source: Brent Millar